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Should I Have High Yield (Junk) Bonds In My Portfolio?

Summary By buying junk bonds I would take on more risk. The trade off is I would expect better returns. Do high yield junk bonds belong in my portfolio? Junk Bond Risks Companies that have low credit ratings pay higher interest rates, but of course those rates come with higher risk of default. Below we show data from Fitch that shows historical default rates. Non-investment grade (junk) rating consists of data rated BB and below. As can be seen default rates rise quickly as rating grades get worse. Fitch Global Corporate Finance Average Cumulative Default Rates: 1990-2013 1 year 2 year 3 year 4 year 5 year 10 year AAA 0 0 0 0 0 0 AA 0.03 0.03 0.07 0.13 0.19 0.24 A 0.08 0.22 0.38 0.52 0.71 1.82 BBB 0.19 0.66 1.19 1.76 2.36 4.64 BB 1.09 2.68 4.27 5.71 6.95 10.94 B 1.94 4.54 6.87 9.01 10.88 11.44 CCC to C 23.51 31.48 34.96 37.01 39.58 39.54 Investment Grade 0.11 0.35 0.61 0.88 1.17 2.27 Speculative Grade 2.88 5.33 7.38 9.16 10.70 13.38 All Corporate Finance .73 1.43 2.04 2.59 3.07 4.07 It is wise to keep in mind that during severe market corrections ratings tend to get downgraded and default rates increase. Fitch-Rated Global Corporate Finance Issuer Default Rates Default Rates 1990-2013 Year Default Rate (%) 1990 1.36 1991 2.25 1992 0.65 1993 0.00 1994 0.00 1995 0.11 1996 0.29 1997 0.08 1998 0.42 1999 0.85 2000 0.38 2001 0.90 2002 2.17 2003 1.16 2004 0.12 2005 0.32 2006 0.07 2007 0.10 2008 1.28 2009 2.58 2010 0.49 2011 0.30 2012 0.65 2013 0.51 As we can see above during both the Tech Wreck and the Great Recession defaults increased substantially. Junk Bond Returns compared to 5 Year Treasuries Portfolio Visualizer provides some excellent tools for backtesting. I used their tools to generate a backtest for comparing High Yield Bonds to 5 Year Treasuries. Portfolio 1 – High Yield Bonds – As represented by Vanguard High Yield Corporate (MUTF: VWEHX ) Portfolio 2 – Five Year Treasuries (click to enlarge) (click to enlarge) As shown about High Yield bonds did return slightly more, but had a much larger maximum drawdown and worse risk adjusted returns based on the Sharpe Ratio and the Sortino Ratio. (click to enlarge) The year -by- year comparison shows that treasuries performed well when the equity market was correcting while High Yield bonds performed poorly. Conclusions Junk Bonds had a slightly higher CAGR over the 1990-2013 time frame, but the advantage was small 7.11% to 6.59% and Junk Bonds actually trailed the treasuries from 1990-2011. Was the small advantage in CAGR worth the risk? The maximum drawdown for the junk bonds was -21.29% the max drawdown for the Treasuries was -4.33%. Junk bonds had a Sharp Ratios of 0.41 and Sortino Ratio of 0.75 compared to a Sharpe Ratio of 0.59 and a Sortino Ratio of 1.40 for the treasuries. I’m semi-retired and bonds are the low-risk part of my portfolio. The possibility of a 20% plus drawdown in the ‘safe’ part of my portfolio makes be lean toward selecting the treasuries. When you add in the fact that the high-yield bonds barely beat the treasuries in total returns it’s a no-brainer. Not only did junk bonds have larger drawdowns they had them at the worst possible time. When equities were taking a beating in 2008 High Yield bonds were going right down with them: -21.29%. Treasuries were up 13.32% in 2008; this is exactly the kind of negative correlation I want my bond holding to display during an equity market correction. Junk bonds have taken a hit lately and the spread between high yield and investment grade bonds has widened. Some investors may view this as an opportunity. I still do not view the risk/reward favorably. If I need higher returns I would be inclined to add more equities and keep my bond investments in Treasuries or investment grade corporate bonds. Bonds are in my portfolio to provide safety, smoothing out my returns and keeping me from having to sell losing investments during a correction. Junk Bonds don’t fit the bill. I won’t be adding junk to my portfolio. I am not a professional advisor or researcher. I am an individual investor who studies investing and shares my thoughts. I encourage all investors to do their own due diligence and please share your findings. I strongly feel the best thing about Seeking Alpha is the sharing of ideas. Please comment; I value your input. Divergent opinions are welcome.

4 Outperforming Country ETFs Of 2014

Amid a myriad of economic and political woes, the stock markets across the globe have given mixed performances. While 2014 is turning out as another banner year for the U.S. stock market with multiple record highs on several occasions, international investing has not been so encouraging. This is especially true as Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) targeting the international equity market has lost about 4% this year compared to a gain of 5.3% for iShares MSCI ACWI ETF (NASDAQ: ACWI ) , which targets the global stock market including the U.S. A strong dollar, Russia turmoil, slump in key emerging markets, sliding oil prices, speculation of interest rates hike faster than expected, and concerns over the global slowdown continued to weigh on the international stocks. Though developed markets started the year on a solid note, these lost momentum with Europe struggling to boost growth and inflation, and Japan suffering from the biggest setback following a sales tax increase in April that has pushed the world’s third-largest economy into a deep recession. Among developing nations, Russia has been hit hard owing to Western sanctions and a massive drop in oil prices while Greece saw another political chaos. On the other hand, India and Indonesia have shown strong resilience to the global slowdown driven by positive developments, election euphoria, new reforms and monetary easing policies. In particular, Chinese stocks have no doubt given impressive performances with the Shanghai Composite Index touching the major threshold of 3,000 for the first time in three years. The massive gains came on the back of speculation that the loose monetary policy measures will revive the dwindling economy and pump billions of dollars into the country. Additionally, growing investor confidence following prospects of a rebound in the Chinese economy, a stabilizing real estate market as well as the launch of the Shanghai-Hong Kong Stock Connect program propelled the Chinese stocks higher in recent months. There are several country ETFs that not only delivered handsome returns this year but also crushed the broad U.S. market fund. Below, we have highlighted a few of these strong momentum plays, which could be interesting picks for investors heading into the New Year. iShares MSCI India Small Cap Index Fund (BATS: SMIN ) – Up 48.3% This product provides exposure to the small cap segment of the broad Indian stock market by tracking the MSCI India Small Cap Index. Holding 180 securities in its basket, it is widely spread out across number of securities with none holding more than 2.67% of assets. Financials takes the top spot with one-fourth share followed by consumer discretionary (19.8%), industrial (18.4%) and materials (10.2%). The fund has been able to manage assets worth $24.1 million while sees light volume of about 16,000 shares per day. Expense ratio came in at 0.74%. SMIN is up over 48% this year and has a Zacks ETF Rank of 2 or ‘Buy’ rating with a High risk outlook. PowerShares China A-Share Portfolio (NYSEARCA: CHNA ) – Up 43.18% This is an actively managed ETF providing exposure to the China A-Share market using Singapore exchange FTSE China A50 Index futures contracts. The product is unpopular and illiquid with AUM of $5.3 million and average daily volume of around 8,000 shares. It charges 51 bps in fees per year from investors and has surged about 43% this year. iShares MSCI Philippines Investable Market Index (NYSEARCA: EPHE ) – Up 22.4% This product targets the Philippines stocks in the emerging Asia Pacific space and tracks the MSCI Philippines Investable Market Index. The fund has amassed $365.3 million in its asset base while trades a good volume of 236,000 shares a day. It charges 61 bps in annual fees. The fund holds a small basket of 43 firms with 61.5% of assets invested in the top 10 holdings, suggesting a high concentration risk. More than one-third of the portfolio is dominated by financials while industrials occupy the second position with 22.4% share. The fund has added over 22% this year and has a Zacks ETF Rank of 3 or ‘Hold rating with a Medium risk outlook. iShares MSCI Indonesia Investable Market Index Fund (NYSEARCA: EIDO ) – Up 20.76% This fund provides exposure to the Indonesian equity market by tracking the MSCI Indonesia Investable Market Index. Holding 102 securities in its basket, it is concentrated on both sectors and securities. The product puts about 44% in the top five holdings while financials dominates the fund’s return at 37.1%. EIDO is the most popular ETF with AUM of $578.4 million and average daily volume of nearly 665,000 shares. Expense ratio came in at 0.61%. The fund is up 20.8% so far in the year and has a Zacks ETF Rank of 2 with a High risk outlook. Bottom Line Investors should note that some specific emerging market ETFs have outperformed this year and will likely continue this trend in 2015. This is especially true, as a slump in oil price has created a major headwind for many key emerging nations or oil producing nations. Also, some developed economies are facing problems in reinvigorating growth.

A Top-Ranked India ETF To Tap The Growing Consumer Sector

The Indian stock market has hardly looked back from the astounding journey it set forth on in May 2014 following the formation of the new government. Most economic factors are presently in favor of Asia’s third-largest economy, including the revival of the currency, a drastic fall in inflation thanks mainly to the oil price crash and an improvement in current account deficit. India’s wholesale price inflation – which was an acute concern leading to a series of rate hikes in the past couple of years – plunged to a five-year low in September. Though India’s Q3 GDP growth rate of 5.3% was not great, analysts from HSBC expect over 6% growth rate from this nation next year. This is noteworthy since the nation’s bourses suffered a lot last year as foreign investors remained skittish about putting more capital in the nation, leaving many questions about the potential of the country in the near term. Actually, given that India isn’t a commodity-oriented emerging market like its BRIC brothers Brazil or Russia, the nation has immensely benefited from the recent natural resource weakness. If this is not enough, Credit Suisse forecasts that Indian economy will log ‘fastest USD nominal growth in the world’ next year as noted by Reuters. To add to this, Credit Suisse believes that Indian equities are not pricey relative to the nation’s growth outlook. This recent bullish tone did spread cheers across every corner of the Indian economy as evident by at least a 25% return received from each India ETF this year. However, some specific corners need special mention. One such space is the Indian consumer sector. What Drives Consumer Sector Higher? The middle income population in India is mushrooming. This fraction of the population has an inclination to spend on discretionary items like travel and leisure which in turn boosts the sales of consumer products like automobiles and personal goods. For example, auto sales displayed a speedy annual expansion of 10% in November (yoy). Notably, auto sales are often regarded as a well-being of an economy. Lower fuel prices seemed to have done the trick. Moreover, with cooling inflation, many are speculating a rate cut in the coming days, though no such thing has taken place formally as of yet. And if in any case, the interest rate goes down, the auto industry should soar. India basically has a compelling investment proposition with its rising importance as a ‘consumer driven’ economy. As per Indian Brand Equity Foundation (IBEF), the present consumer spending will likely grow two-fold by 2025. The consumer confidence score rose to 126 in Q3 of this year from an all-time low of 92 reached in Q1 of 2010. The market is motivated by favorable demographics and expanding disposable income. IBEF also predicts that per capita income in India will likely see a meaningful CAGR of 5.4% within the span of 2010-2019 with food products and personal care taking about 65% share of the market revenue. Other forecasts by IBEF include doubling of the consumer durables market by FY15 from FY10. The young generation’s inclination toward tech-driven products will also facilitate this growth trajectory. This calls for a bullish stance over the consumer sector of the Indian economy. Here we would like to highlight the Zacks top-ranked ETF providing exposure to this very corner of the Indian market. EGShares India Consumer ETF ( INCO ) has a Zacks ETF Rank #1 (strong Buy) with a Medium risk outlook and we expect it to outperform most of its peers in the coming months meaning it could be an excellent pick for investors seeking more exposure to this economy. INCO in Focus This ETF targets the consumer industry of India and follows the Indxx India Consumer Index. It holds 30 stocks in its basket and has amassed $21.5 million in its asset base. The fund trades in a paltry volume of 15,000 shares, suggesting additional cost in the form of wide bid/ask spread beyond the expense ratio of 0.89%. The fund offers a moderately concentrated bet in the top 10 holdings as indicated by its 52% exposure to these stocks. Among individual holdings, MRF Ltd., Motherson Sumi Systems Ltd. and Bosch Ltd form the top positions of the fund with total investment of 17.7%. The fund allocates 79.42% of its asset base to consumer goods. A small proportion of the asset base has also been assigned to Industrials (15.4%) and Consumer Services (4.8%). Industry-wise, automobiles – which is presently a well-performing sector in India – accounts for 37.5% followed by personal goods (27.14%) and industrial engineering (15.4%). INCO has hit a low of $19.64 and a 52-week high of $34.89. The fund is currently hovering near its 52-week high price and could be an interesting choice in 2015 for investors seeking more Indian market exposure.